A capital markets union could kick-start growth across Europe

As Lord Hill is grilled by MEPs for a second time, William Wright on why a
capital market union could be a good idea

EU referendum: what and when - everything you need to knowPhoto: REUTERS/STEFAN WERMUTH

By William Wright

1:07PM BST 07 Oct 2014

It would be easy to dismiss “capital markets union” – one of the big ideas of the new European Commission under Jean-Claude Juncker – as little more than another eurocratic slogan or political diversion.

The confirmation hearing in the European Parliament for the British commissioner Jonathan Hill, who, if he is approved, will have the vaguely Stalinist-sounding title of “Commissioner for Financial Stability, Financial Services and Capital Markets Union”, has been something between a political show trial and a Soviet-style centralised planning meeting to set the economic action plan for the next five years.

But strip away the politics and capital markets union could unlock trillions of dollars in capital to invest in businesses and infrastructure in Europe, helping to kick-start economic growth and attack stubbornly high unemployment. For good measure, it could slash the cost of raising capital for smaller businesses and significantly reduce the costs to investors of their ISAs, mutual funds and pensions.

The idea of capital markets union is a recognition that Europe needs to break the link between its flatlining economy and its over-reliance on bank lending. In the eurozone, gross new lending to businesses has fallen by more than 40pc since its peak in 2008 and is lower today than it was a decade ago. Banks are struggling to shrink their balance sheets after a lending binge in the decade before the financial crisis and are in no position to help companies borrow their way out of trouble. The problem is that capital markets in Europe are not deep enough to take up the slack. More than 20 years after the official launch of the single market, and after a barrage of more than 40 separate pieces of financial legislation under Lord Hill’s predecessor, Michel Barnier, we still have “capital markets disunion” in Europe.

For all the progress that has been made, capital markets in Europe are a hotch-potch of fragmented national markets with separate rules, regulations and business practices. A genuine “European” market exists only for the biggest companies and the most sophisticated banks and institutional investors. This dislocation is holding companies and investors back and is placing extra burdens on an already creaky and bloated banking sector.

Capital markets in Europe are on average just half as developed relative to the size of the economy as they are in the US, according to analysis of more than 20 different measures. In some areas, the gap is even starker: the high-yield bond market in Europe is just one third the size of the market in the US relative to GDP, which translates into more than $150bn in “lost” financing a year. The European venture capital industry would be roughly five times bigger if it were the same size relative to the economy as in the US. That means a lot of future potential European Googles, Facebooks and biotech companies are not getting the funding they need.

All in, there is a shortfall of more than $1 trillion a year between what companies in Europe raise in the capital markets – by selling shares, bonds, or loans – and what they could potentially raise if markets were as deep as in the US. A lot of that money isn’t being raised at all and therefore isn’t being invested in the European economy. The rest is gumming up bank balance sheets unnecessarily and making it harder for them to lend on competitive terms to smaller companies who need and deserve loans.

Removing some of these artificial national barriers, such as rules on what sort of assets pension funds can invest in, would bring tangible benefits. As more capital flowed across borders in search of investments, it would help break down cosy national cliques in the financial industry, increase competition and reduce costs.

If you own or manage a business, deeper capital markets would give you a wider choice of more flexible financing at more competitive rates. As an investor, you would pay lower trading commissions, the fees on your ISAs and mutual funds would be lower, and less of your pension would be eaten up by costs.

Building a capital markets union during the five-year tenure of Mr Juncker’s commission will not be easy but it is one piece of centralised planning that even the most free market liberals should support.